Executive financial incentives and payout policy

"Using the 2003 reduction in dividend tax rates to identify an exogenous change in the after-tax value of dividends to shareholders, we test whether the composition of executives' stock and option holdings is an important determinant of payout policy. We find that when top executives have greater stock ownership, and thus have the incentive to increase dividends for liquidity reasons, there is a significantly greater likelihood of a dividend increase following the 2003 dividend tax cut, whereas no such relation existed in the prior decade when the dividend tax rate was much higher. In contrast, executives with large holdings of stock options, whose value is negatively related to the amount of dividends paid, were less likely to increase dividends both before and after the tax change. These findings hold for dividend increases in general, as well as dividend initiations, and are robust to a rich set of firm and shareholder characteristics. Our results suggest that about one-half of the unanticipated rise in the likelihood of a dividend increase or initiation observed in 2003 can be attributed to the stock vs. option composition of top executive holdings. Many of the firms that increased dividends in 2003 scaled back share repurchases, leaving total payouts little changed. This substitution may have raised the total tax burden on distributions because share repurchases are still tax-advantaged relative to dividends. We find that while dividend-paying firms with a large fraction of individual shareholders saw the biggest stock price gains in response to the tax cut, the market appears to have at least partially anticipated for which firms the tax cut would most likely lead to a substitution of dividends for share repurchases or earnings retention and thus a higher average tax burden on total distributions for individual shareholders"--National Bureau of Economic Research web site.